I've heard FSI's and SIFMA's arguments that small clients can't be served by advisors under a fee-based system, cost-effectively. Yet, it is a false argument made in an attempt to frame the DOL's fiduciary rule as "bad" for investors.
Can small investors be better served in a commission-based environment. Let's examine the evidence.
First, there are many fee-only advisers, as well as robo-advisor platforms, that offer low-monthly-subscription-fee or low-AUM fees or flat fees or hourly fees for advisory services. In fact, after the DOL rule was finalized, a couple of dual registrant firms announced the LOWERING of their minimums, in connection with fee-based accounts, in order to serve small clients.
Many, many advisors currently work under a fee-only platform, and many (if not most) of them serve small clients. And most of them are actually trained to provide both financial and investment advice (not just sell products). Consumers should just look for advisors by visiting the web sites of Garrett Planning Network (www.GarrettPlanningNetwork.com), XY Planning Network (www.XYPlanningNetwork.com) and many members of the National Association of Personal Financial Advisors (www.NAPFA.org) and the Alliance of Comprehensive Planners (www.acplanners.org). [Disclosure: I have served as a consultant to Garrett Planning Network in terms of providing educational content to them, and I am a member of NAPFA.]
Second, being sold a product on commission is not "cheaper"; in fact, it is far more expensive to small investors. In my experience, most brokers go out of their way to ensure that their commissions are not cut via breakpoint discounts, by spreading client funds over several fund families. (I've seen this again, and again, and again). So, let's examine the typical fees paid by clients sold Class A mutual fund shares:
1) 5.75% sales load. What is the impact of this? Assuming a 10% level annual rate of return for a stock fund, the fund must secure a 1.20% greater annualized return for the fund to "break-even" with a no-load fund, over a 5-year time horizon. If the fund were held for 10 years, the greater return required is 0.59%. If the fund were held for 15 years, then the break-even is 0.43%. But, here's the catch - the average stock fund is held for 4 years, and the average bond fund is held for 3 years, according to the ICI.
2) Class A shares also typically possess a 12b-1 "marketing fee" (80% of these collected fees are passed on to brokerage firms, on average). This fee is typically 0.25% a year.
3) Funds sold through the broker-dealer channel typically have fairly high commission structures, due to excessive trading of securities within the fund, using full-service brokers as the chosen brokers for such trades, and payment of soft dollars. While the impact may only be a few basis points, or in excess of 50 basis points (or even much more), the fees add up! Add in bid-ask spreads, which in turn fuel back to the brokerage firms payment for order flow, and even more costs are extracted from investors.
4) The funds sold by broker-dealer firms usually have higher management fees. In turn, these higher management fees often are used, in part, for revenue sharing payments, such as "payment for shelf space."
5) The funds sold by broker-dealer firms are often tax-inefficient. Not enough brokers structure portfolios tax-efficiently, nor do they utilize tax-efficient stock mutual funds. This results in a substantial tax drag on investment returns that often could be avoided, or at least minimized.
Fees and costs matter. A huge body of academic research shows that the higher the product fees, the lower the returns to investors, all other things being equal.
Third, the payment of commissions on mutual funds is counter to Modern Portfolio Theory, in particular a strategic or tactical asset allocation methodology and the necessary rebalancing undertaken in conjunction with same. Unless the fund is a target date fund (or similar fund) (which may have even higher costs, or may not be tax-efficient if the client has accounts with different tax characteristics), then rebalancing of the portfolio should be undertaken. Of course, this leads to more commissions. IN ESSENCE, COMMISSION-BASED MUTUAL FUNDS ARE CONTRARY TO THE SOUND MANAGEMENT OF AN INVESTMENT PORTFOLIO.
Fourth, the "suitability standard" that currently governs broker-dealers and their registered representatives no substantial duty of due care upon the firm or its representatives. They are not required to possess expertise in investment portfolio design, nor in investment product selection. There is no fiduciary duty of loyalty. Hence, there is no duty to truly evaluate and select the BEST mutual funds or other investment securities for the client. In essence, the current and inherently weak and vague suitability standard is the underlying foundation upon which a product distribution network has been built. This product distribution scheme is purposely designed to obscure the many, many fees and costs investors are incurring.
Fifth, for ongoing advisory fees small clients get more and better service, at less cost. For the 1% (or higher, or much lower) annual AUM fee charged by some fee-only advisors (which FSI and SIFMA tout as "too expensive" for small investors), nearly always substantial additional financial planning services are provided, fiduciary responsibility is assumed, and an ongoing duty to monitor the portfolio exists. It's just not an apples-to-apples comparison, to begin with.
In essence, small clients get FAR MORE SERVICE and BETTER ADVICE from fee-only, fiduciary advisers, than they do from the vast majority of stockbrokers (i.e., registered representatives of broker-dealer firms).
An Aside: Use of Variable Annuities to Enhance Compensation, Avoid Breakpoint Discounts. To avoid breakpoint discounts for clients who seek to invest more than $25,000, many brokers have turned to the use of variable annuities. Yet, many broker-sold annuities have total annual fees and costs of 3%, 4% or higher. While "guarantees" exist - such as the death benefit guarantee, and possible lifetime withdrawal guarantees - the costs of these guarantees, the restrictions imposed when they are chosen, and the relatively low annuitization rates (upon annuitization, which is necessary to secure various lifetime withdrawal benefit guarantees) - all combine to negate the attractiveness of these guarantees. In essence, such guarantees fail any reasonable cost-benefit analysis, from the perspective of the investor (or the fiduciary advisor of the investor).
Economic incentives matter. Remove the incentives to recommend high-cost products that pay the firm or its representatives more, and the client - including the small client - receives much better investment recommendations, for often far less total fees and costs. And the all-so-important financial planning advice is also included, as part of the lower fees paid.
What About Municipal Bonds? One could argue that a client who desires municipal bonds would be better served in a commission-based environment. But that ignores the present reality that municipal bonds require ongoing monitoring of the issuer in most instances. Also, a true fiduciary firm would seek to aggregate bond purchases for its many clients, in order to secure substantially less principal mark-ups. Additionally, any "average mark-up" paid by a client can easily be translated into an ongoing advisory fee charged to the client, instead.
It's Time to Speak Up, To Counter FSI/SIFMA's Falsehoods.
All fiduciary advisors need to push back against FSI and SIFMA's false statements.
All fiduciary advisors need to let their U.S. Senators and U.S. Congressmen know that FSI and SIFMA are not trying to stick up for small investors, but rather stick it to them.